Early adopters weigh in on ferrous scrap futures

A number of financial companies and trading firms are already working with the new ferrous scrap contract. What do these early adopters think? Several spoke with AMM to discuss their experiences using the new financial tool and to share their thoughts about its future.

Bradley Clark, director of steel trading, Kataman Metals LLC, St. Louis:We buy steel and scrap. We hold inventory and we hedge that, so we use all the tools available to us. We use the HRC (hot-rolled coil) and the scrap contract to offer customers solutions they would not otherwise get, but on its own the scrap contract will take several years to take off. Look at iron ore: it took about 10 years, but it was a real success story.

As an analogy, freight was oversupplied and depressed for about 50 years. Around 2005, when China started to build its infrastructure, freight went through the roof. But the shippersÑgrain, coal, iron oreÑhad experience in the futures market because of the underlying commodities so they were able to use hedging.

Some mills and yards are not familiar with hedging on an exchange, but that will change over time. People note that the HRC contact is doing well. But it is not just after five years; there were two years of development before that. So figure seven years for the new scrap contract or others on different exchanges. Its like a dance. The more people on the floor, the more want to come on the floor. But just having a few people out there dancing their heads off can sometimes be a hindrance.

Spencer Johnson, risk manager, INTL FCStone Inc., New York:We actively work as a broker in all the ferrous markets, but due to liquidity constraints in scrap we are primarily dealing with iron ore and HRC (hot-rolled coil) on a day-to-day basis. ... Scrap (is) more of a secondary focus due purely to liquidity, not necessarily because of a lack of new customer interest.

We continue to find new interest throughout the ferrous space, but interest in busheling is definitely strong. ... Conceptually speaking, the interest in the busheling contract has been mostly quite positive. There are some players who, as expected, do not feel any need to hedge their ferrous scrap even as they actively hedge most of their nonferrous material. However, for those who are already in the market and looking to trade, the reality of liquidity quickly tests the patience of those involved.

That said, the contract offers a unique and highly useful opportunity to the scrap consumer and the recycler. The primary advantage we see is in the scrap recyclers ability to offer forward-fixed pricing to steel producers through use of the busheling contract. Many of the steel producers would see the benefit of knowing their raw material costs in advance, and thus a fixed-price offering from the recycler could be a promising new way of locking up mill buyers into agreements without exposing the recycler to the risk that they may have agreed to a price that will eventually be below the spot mill settlement.

There is no competition with busheling for a domestic U.S. scrap risk-management tool. The only other option (on pricing), c.f.r. Turkey, is generally seen as too high a basis risk even while acknowledging historical (value) correlations that are very high.

A source at a financial trading firm who wished to remain anonymous:(Our) initial experience with client interaction and scrap products is good. We are not happy with the AMM busheling index publishing only once a monthÑit needs to publish at least once per week to grow liquidity (and) market participation and (to) allay concerns of too few data points to make a hedging decision.

(Our experience has been) positive, other than the slow build in liquidity. Depending on the overall economy in general and steel prices in particular, we expect the growth to be an initial slow climb (followed by) rapid acceptance once further traction is gained.

Andre Marshall, chief executive officer, Crunch Risk LLC, HoustonScreen activity has been sporadic, but screen activity this early in a contract is quite positive. A few trades have cleared through ClearPort, which Ive done most of; still small, but building.

The last trade was a February/August strip, which was the first sign of strip transactions. Strips should grow. Hedge buyers have consistently been in the market for strips and individual months for the past month-plus. Sellers (are) starting to surface here now as well. (The number of) companies signing up to trade has been growing as many companies prepare to participate.

Activity so far has been extremely modest. However, the level of interest has been growing exponentially.

Nick Webb, metals group vice president, Jefferies & Co. Inc., New York:As with any new futures market, the early days are consumed by educational discussions to ensure customers and prospects fully understand all benefits and risks. ... Derivatives are still very new for the industry and in some cases (are) adamantly opposed, so proper education is imperative to the long-term viability of these markets. Trading volumes remain very light, but we expect this to improve as new participants enter the market.

For the most part, the initial feedback has been positive. Very few customers (or) prospects argue that this is the wrong product or index for a viable market.

I expect the adoption of this market to be very gradual, as the industry will absolutely require a robust, consultative approach in order to consistently get the bigger players on board. This is in line with the maturation process of other futures markets as well, as copper and aluminum took the better part of a decade to get to full liquidity.

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